Richard C. Longworth, senior fellow at The Chicago Council on Global Affairs, contributes his knowledge and ideas about issues that affect the Midwest.

Tuesday, August 19, 2014

Blowing Smoke on Corporate Taxes

American corporate leaders love to complain about the nation’s high corporate tax rate, one of the highest in the world. This rate, they say, is stifling business investment and encouraging U.S. corporations to move their headquarters to other countries.

It sounds logical. But it may not be true. A scholarly look at global tax payments, coupled with an on-the-ground look at the effect of taxes on business investment, suggests that these corporate leaders not only are crying wolf but may be blowing smoke.

(This may seem an odd topic for this blog this week, considering the urban crisis here in the Midwest, in the St. Louis suburb of Ferguson, where mutual distrust between black residents and white police has exploded into violence. I’m going to give this a pass for the simple reason that I haven’t been in Ferguson in years and know nothing about what’s going on there now. This hasn’t stopped a legion of pundits and tweeters from sounding off, even though they haven’t been there either. I don’t choose to add my uninformed opinion to theirs.)

Now, where were we? Oh yes, corporate taxes.

Corporate leaders have been beating the drum for corporate tax reform, by which they mean corporate tax cuts. The U.S. rate is 35 percent, which is one of the highest in the developed world – Japan’s is highest, at 38 percent – and above the average 24 percent for the 34 advanced countries that make up the Organization for Economic Cooperation and Development (OECD). The rate in France is 33 percent, in Germany 30 percent, in Britain only 21 percent.

Many of these differences aren’t huge but the corporate leaders do have a point that our nominal tax rate is higher than that of most of our global rivals. The trouble is that these rates really are nominal, which the dictionary defines as “acting or being something in name only, but not in reality.”

The reality is very different, as a new paper by a law professor at the University of Southern California, Edward D. Kleinbard, says. According to Kleinbard, the big American corporations – the global corporations which are threatening to pick up and move – actually make out like bandits at tax time.

As any sophisticated corporation knows, there are various tax loopholes to keep that nominal rate nominal. One of the biggest, Kleinbard says, is the practice of keeping much of their income overseas and out of reach of the IRS. Altogether, he said, American corporations paid an effective tax rate of 12.6 percent in 2010, the last year for which figures are available.

Kleinbard said it isn’t the tax rates themselves that are tempting American-based companies to move their headquarters, if not their operations, to relatively low-tax venues such as Switzerland or Ireland. Instead, he said, they want to be able to use that money parked abroad without having to pay taxes on it. He estimates this hoard at $2 trillion: taxed at 35 percent, this would bring in $700 billion, which is more than the total U.S. government deficit.

This discrepancy between appearance and reality is an old story in Illinois, where major corporations such as Caterpillar regularly threaten to move to other states unless the state trims its 9.5 percent corporate tax. In fact, the state’s biggest corporations pay an average 3 percent in taxes and some pay nothing at all.

Does any of make any difference to corporate investment decisions, or any difference at all except for lowering corporate taxes and putting more of the burden on individual taxpayers?

The evidence is slim. Officially, the most “business tax-friendly” states, according to the Tax Foundation, are Wyoming, South Dakota, and Nevada. None of these is exactly overwhelmed by corporate investment. The reason, of course, is that big global corporations want to be in big cities, which have the best business services, the biggest airports, the best broadband, and the most amenities. All these benefits cost money: in the end, corporations will pay what they have to pay to be where the action is.

A story by Crain’s Chicago Business underlines this. According to this story, major real estate investors are paying record prices to buy property in Chicago and Illinois. That’s the same Chicago and Illinois that are staggering under huge public deficits, including unmet pension obligations, that seem certain to bring on property tax and other tax increases, sooner rather than later.

These investors know this, and are buying into the city and state any way. Why? Because they need to be here.

“Most, if not all, of our national retailers want to be here,” a real estate executive told Crain’s. “Chicago is one of the great cities and our retailers, whether they’re local, national or international, recognize that.”

Another executive said companies are simply building these expected tax hikes into their prices, confident they can recoup them.

This isn’t just true of Chicago, of course. Other major cities – New York, London, San Francisco - are seeing real estate and other costs soar, because so many corporations and global citizens want to invest there. These costs aren’t driving anybody away: instead, more and more people want in.

Actually, these costs are in fact driving some people away. These are the middle class and working class citizens of these cities, who are being priced out of town. Instead of cutting taxes for corporations and giving them tax breaks and other bribes to move in, the country and its cities and states would be smart to tax the corporations, which will pay if they have to, and use the money to subsidize ordinary workers who will indeed move out if they have to.

1 Comment

Mr. Longworth, I hope you will touch on the developments and broader ramifications of what's going on in Ferguson, MO, going forward. It's become an international story originating in the Midwest, too important to ignore.

In the meantime,speaking of Ferguson and Corporate globalization, this piece by STL Post-Dispatch online's Kevin Horrigan thoughtfully touches on both:

Excerpt:
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"Emerson is No. 121 on the Fortune 500 with 2013 revenues of $24.6 billion. Some 1,300 St. Louisans are employed at the Ferguson campus, most of them doing highly skilled financial and management work.

Emerson employs a lot of less-skilled people to make a lot of different stuff, but not in Ferguson..."

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